Aer Lingus, Cathay and others face fundamental questions: What to do with a broken airline model?

Airports, aviation suppliers and manufacturers, financiers, the tourism sector and passengers beware: there are unprecedented numbers of airlines flying today with badly broken business models. The global economic downturn and health pandemic has severely dented the revenues of airlines whose margins are brittle in the best of times. Premium travel has collapsed and there are now fundamental questions being asked about the timing and extent of a recovery in this crucial sector. That word "fundamental" is appearing now with chilling regularity.

The current Northern Summer travel peak is masking many of the deep structural flaws besetting the industry. But as the holiday hordes now fade, the bleak reality is setting in for many airlines. In the absence of a miracle economic recovery, the airline industry is in for its coldest ever Winter. There could be numerous casualties.

International Air Transport Association (IATA) recently observed that "structural declines" in premium traffic are now occurring, particularly in Europe. IATA stated the deterioration in premium travel is occurring, despite the better economic news declared by Germany and France. IATA noted that passengers who had previously paid premium fares to travel on short-medium haul European routes “and have now moved to the back of the aircraft, or onto low fare airlines, may not return”. This is a vital ingredient in full service airlines' subsistence diets.

IATA has noted that though demand improved in Jul-2009, “we have seen little change to the unprecedented fall in yields and revenues”. Director General and CEO, Giovanni Bisignani, noted, “the months ahead are marked by many uncertainties, including the price of oil. The road to recovery will be both slow and volatile. In the meantime, the industry remains in intensive care”. Oil prices have risen 65% this year and are hovering around USD70 per barrel.

In the US, the Air Transport Association this week stated, “while the modest improvement in demand from June to July would normally be cause for cautious optimism, the fact is that the number of air travelers continues to fall despite double-digit declines in fares. Clearly, with the difficult economic environment, demand for air travel remains weak”.

"A structural upheaval"

Acress the Atlantic, the Association of European Airlines (AEA) current Chairman (and President and CEO of Croatia Airlines), Ivan Misetic, said in May-2009 that the economic downturn is of “unprecedented dimensions”, adding “we do not know when the downturn will bottom out”. AEA CEO consensus was that the downturn would have a “profound impact on the market, extending well beyond 2009”. Mr Misetic, stated, “this is not a cyclical feature in an industry which is used to business cycle - it is a structural upheaval, and we must adapt structurally”.

The Association of Asia Pacific Airlines (AAPA) also observed this week that a “return to growth is still some way off”, despite some “encouraging signs of broader economic rebound taking shape across the region”.

In short, “buckle up”! The skies ahead are dark and stormy.

Full service business models under serious threat

In conditions like these, the usual responses, of cutting costs and generally tightening belts, are no longer enough. This time, the problem is fundamental.

In recent weeks, many of the world’s major airlines have made some sobering observations about the current state of affairs, specifically, the unsuitability of their business models both now and into the future.

To take “necessary steps to address our business model”

Unveiling an almost quadrupling in net losses in the first half to 30-Jun-2009 (as average fares slumped 17%) Aer Lingus Chairman, Colm Barrington, stated “we must now take difficult, but necessary steps to address our business model and cost base”. The airline, under new CEO, Christoph Mueller, will conduct an “exhaustive and wide- ranging examination” of its operations, with “nothing ruled in or out.”

“May need a fundamental change”

Another carrier that has embarked on a major review of its business model, is Hong Kong-based Cathay Pacific. This month the airline warned its current model "might not be sustainable, if we have to face up to a 'new normal' in our business". The review will look at cost management, as well as revenue initiatives and to "assess what configurations [of business model] we may need".

Earlier this month, CEO Tony Tyler stated, “in the past, after recessions, premium traffic has bounced back. I hope it will again, but I don't know”. This week, Mr Tyler added, “now we need to take a long hard look at how to make our business succeed if things don't improve on the revenue side. We simply cannot afford to see our cash levels continue to be depleted even as our debt levels rise, and if the current collapse in premium revenues and cargo turns out to be structural rather than cyclical, we may need a fundamental change in the way we do things”.

Faces “fundamental challenge" to its business model

British Airways has been saying for some time that the industry is facing its “biggest crisis ever”, with Chairman, Martin Broughton noting the company faces a "fundamental challenge" to its business model. Mr Broughton has said the market for first and business-class travel may never fully recover, noting, “there is evidence that business customers no longer place the same value on the levels of flexibility offered in the highest fare categories. Corporate travel budgets have been cut back severely and consumers are determined to reduce their debt”.

Sees more cuts as “a matter of survival”

Scandinavian airline, SAS, is cutting as many as 1,500 more jobs and reducing wages after reporting a wider second-quarter loss. SAS started the year with 23,000 employees and job cuts for some 9,000 staff have now been announced. Chief Executive, Mats Jansson, stated, “SAS must compete on the same basis as its competitors, which ultimately is a matter of survival”.

“To rethink parts of our business model”

Lufthansa, which suffered a deep first half loss, is now taking a serious look at its business and future capacity plans. Spokesman, Roland Busch, stated last month, “we will have to rethink parts of our business model and possibly change them. Mr Busch added, “the proportion of passengers travelling at the normal price has been shrinking drastically for a while, especially on European routes. Also within the business or economy class we are seeing a massive slide from higher-priced booking classes to cheaper tickets."

While Lufthansa is maintaining its aircraft delivery schedule for 2009, the carrier is now examining aircraft delivery dates beyond this year.

Needs “a clear change of course”

Finnair’s President and CEO since 2005, Jukka Hienonen, resigned abruptly this month, stating he was not satisfied with the pace of change in the airline in response to the current challenges. Mr Hienonen stated, "a clear change of course is required”, but noted “some personnel organizations have shown no willingness to adapt." Mr Hienonen stated, “many structures, as well as the company’s culture, have been formed in totally different conditions. With these we cannot do well in the present competitive environment, but changing has proved to be extremely difficult”.

The airline unveiled a second quarter loss as unit revenues plunged 15%. Mr Hienonen stated, “our industry sector is facing its deepest crisis. Finnair, too, has suffered from the collapse of average prices caused by the decline in air travel.”

“Cannot rely on government subsidy indefinitely”

Another new CEO appointee, Samer Majali (the former Royal Jordanian CEO), also sees the need for fundamental change at his latest airline challenge: Gulf Air. Last week, Mr Majali put it bluntly, “Gulf Air is currently not sustainable and is receiving subsidies, which could otherwise be invested in other parts of the national economy”. He added, “we cannot rely on government subsidy indefinitely so we also need to build a self-sufficient and commercially successful airline”.

A comprehensive review of the Bahrain-based carrier’s business model has already started and a series of recommendations would be revealed by the end of this year. Mr Majali warned, “we do not yet know what size or shape Gulf Air will take following this review”, adding “it may be necessary for us to look at our fleet orders with our suppliers and to adjust them according to the airline's newly defined requirements." The airline is expected to seek to join a global airline alliance, as part of its strategy for tackling years of decay.

Preparing a new operating structure

For Japan Airlines, joining oneworld has not been the answer to its deep problems. Another round of deep restructuring is now under way at JAL, under the watchful eye of the government, which is participating heavily in up to USD1 billion in loans to help the airline ride out a slump in demand. In early Aug-2009, JAL stated business travel is “projected to remain slow”, noting it would “persevere in the drastic adjustments to our network, down-sizing our aircraft, and implementing ‘nothing-off-limits’ cost-cutting measures to improve profitability”.

JAL’s international yield fell an eye-popping 33.7% in 1Q2009, resulting. The carrier is reportedly considering separating low-margin international routes into a new company or transferring them to subsidiary, JALways.

Poorer as downturn bites

Singapore Airlines, whose yields crumbled 20% in the three months ended 30-Jun-2009, stated yields are “expected to remain under pressure from excess capacity in the market”. SIA added, “if these conditions continue, the Group expects to make a loss for the full year”. After earlier deep cuts, Singapore Airlines plans to implement a 10% pay cut for its non-management staff for three months commencing 01-Aug-09, after the carrier reported a net loss for 1Q2009.

Sees “radical change” to business model

Malaysia Airlines is also suffering from a steep downturn in demand, Managing Director, Idris Jala, stated earlier this year that it is “absolutely necessary” for airlines to change their business models, noting “you need to change it radically to survive and win in such a tough operating environment”. Idris added, “I am very convinced that must be the way to survive in this environment - to tailor [the products] based on the size of the customers' wallet”.

Sees partnerships as “long-term way to succeed”

American Airlines is hopeful its alliance with British Airways and Iberia will be approved by Oct-2009. American Airlines Senior VP, Craig Kreeger, stated last month, “It seems that intra-alliance competition and building a global network with partners is the long-term way in which airlines will succeed, and this [BA-AA-Iberia deal] represents a very big step in that process and an important one”.

Calls for “inefficient airlines to die peacefully”

Virgin Atlantic President, Sir Richard Branson, has been a vociferous opponent to global alliances, recently calling on the US Department of Transportation to “care more about the public and competition than trying to prop up a few inefficient carriers that should be allowed to die peacefully”. Sir Richard added, "I'm not sure that carriers merging is actually a good idea. I think that, generally speaking, carriers should get on and compete with each other."

On economic conditions, Sir Richard noted, “there have been some hopeful signs in the last six weeks, but I think the jury is still out to see whether that's self-sustaining or not”. The airline’s CEO, Steve Ridgway, said late last month the outlook for the industry is “as bleak as ever, and all airlines are having to shrink their businesses. The fittest will survive and be in a stronger position when the economy grows."

Many well-run LCCs are meanwhile reporting solid growth in demand and profits amid the downturn. A big difference: they don't rely on premium traffic for their core profitability.

NB: DAILY LCC SECTOR strategic updates from around the world are NOW AVAILABLE. Sign up today for your free trial subscription to Peanuts! Daily.

Criticises governments for “propping up airlines with out-dated business models”

easyJet recently criticised moves by the European Commission to suspend rules on airport slots that enabled airlines to retain unused slots at European airports this Summer.

CEO, Andy Harrison, stated, “this is not about protecting the industry; it’s about propping-up a few poorly-run, inefficient network airlines with out-dated business models that cannot adapt to the demands of modern consumers. Implementing such a measure would lead to fewer flights, and higher fares, thereby exacerbating the economic situation, not helping it. We must resist this lurch back to the Stone Age of protectionism.”

Sees success by offering lowest prices

Ryanair CEO, Michael O’Leary, stated the winners in a deep recession “will always be those companies, such as Aldi, Lidl, McDonald’s and Ryanair, who offer lowest prices.” He predicts the airline would be alone among Europe’s large carriers “to deliver passenger and profit growth in the current year”. He added declining traffic, falling yields and substantial losses at legacy airlines is “accelerating the pace of airline closures and consolidations”.

“Fundamentally the right business model”

The CEO of Canada’s WestJet, Sean Durfy, said this month, “fundamentally, our business model is the right business model; we've been profitable for the last 17 quarters”. Mr Durfy noted pricing would continue to be “aggressive going forward”, adding “we would like to see more rational pricing in the marketplace, but part of it is...stimulating [consumers] to travel because the economy for a discretionary buy is still very, very weak."

IATA’s Bisignani stated this week that airlines “need to make their money in the June-August peak travel season”. He stated, “planes are full, load factors are high. But revenues are way down. Conserving cash, effectively managing capacity and cutting costs will be the long-term theme for every business in the air transport value chain”.

But conserving cash, effectively managing capacity and cutting costs may not be enough. Established airlines have been doing this for years, with no tangible evidence of an improvement in the fundamental abilities to adapt to market circumstances.

The US airline model has been effectively broken for years and the sector is in a painful but steady march to the bottom. Skirmishes punctuate the sector’s slow decent, including battles with organised labour (which look likely to intensify in coming months), consolidation efforts and alliances.

But these moves only prolong the inevitable. The end result is weakened organisational culture, intractable decay and market shrinkage. Even without the current steep decline, most full service airline models around the world had already become clearly unviable - if making a reasonable return on capital is their purpose for existence.

British Airways’ CEO, Willie Walsh, recently observed a “structural shift” was occurring, noting “it may be that demand in the highest-yielding, fully-flexible premium business market will never recover to the levels we were seeing in 2007”. Mr Walsh stated, “that is a sobering message for all traditional airlines. Premium travel has been central to the viability of their business model for a very long time”.

It has been said many times now, but if these airlines are to survive, they really cannot afford to waste this recession.

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